Larry McDonald is a political policy risk consultant to hedge funds, family offices, asset managers and high net worth investors. As Senior Director, Head US Policy Strategist at Newedge, he's a frequent guest contributor on Bloomberg TV, CNBC, Fox Business, and the BBC. A NY Times bestselling author, his book "Colossal Failure of Common Sense" is now translated into 12 languages. He ran a $500 million proprietary trading book at Lehman Brothers, made over $75 million betting against the subprime mortgage crisis and was consistently one of the most profitable traders in the firm. His "Bear Traps" letter is one of the most highly regarded on Wall St. He's participated in 3 major financial crisis documentaries: Sony Pictures, Academy Award winning documentary the "Inside Job," BBC‘s "The Love of Money" and CBC‘s "House of Cards." He's delivered over 64 keynote speeches in 17 different countries, at Banks, Investment Firms, Conferences, Law Firms, Insurance Companies and Universities.

The likely outcome will be Greece like forbearance agreement forced on bond holders. In other words, with the approval of Uncle Sam, Puerto Rico lowers the coupon on their debt load to say 3% and extends maturities out to 2030 through 2050. It’s a technical default because when this is put into practice, bond prices drop like a stone. Greece bonds which traded at 100 in 2008, touched 18 cents on the dollar in 2011. The pain for investors could be severe without another bailout from US taxpayers. It’s simple math. Mathematics is not Republican nor Democrat it’s the lurking sword which has no friends, especially in Greece. A 9% interest rate on $70 billion of debt is over $6 billion a year of interest expense for a country with a $10 billion annual budget. Even at 4.5% that’s $3 billion of interest costs, or 30% of the budget without even entertaining the thought of Pension and Healthcare obligations.

Soak the Rich

The territory needs to dramatically cut spending and unrealistic promises, but their solution of choice has been tax hikes in order to close these fiscal gaps. Last year, it raised the top marginal rate from 30% to 39%. The next victim is likely to be the corporate tax rate for multinational companies, which have been lured into Puerto Rico due to its favorable corporate tax rate. Some say raising taxes here is killing the goose that laid the golden egg.

Corporate tax rates going from 4% to 6% will generate an additional $1 billion or 13% more in tax revenues. Some of the multinationals with significant assets in Puerto Rico are Johnson & Johnson (JNJ), Abbott (ABT) and Medtronic (MDT).

On average, these companies were able to reduce their tax rate by 150bp through their presence in Puerto Rico. The corporate tax elasticity in reaction to another hike in the rate is the key to Puerto Rico’s survival. Many US companies have spent millions building an infrastructure on the island, but might be inclined to move if the hikes are too harsh.

Demographic Dead Zones

In the 1990s there were 240,000 Puerto Rican citizens were living in Florida, today that number is over 1 million. In 2000, the commonwealth’s population was 3.8 million, thirteen years later that number in 3.6 million. Nothing like rising taxes and an out of control welfare state to drive people to the exits, deja vu Detroit. The Hispanic population of Puerto Rican origin in the US 50 states and D.C. increased from 3.4 million in 2000 to nearly 5 million in 2013. It now surpasses Puerto Rico’s total population by 30%. Nearly a third of Puerto Rican Hispanics now living in mainland US were born in Puerto Rico, according an analysis of by the Pew Hispanic Center.

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